Credit scores are one of the many responsibilities that come with adult life and can be a confusing topic for even the most financially savvy consumers to understand. Most people know that a difference of just 100 points could cost or save you thousands.
Without a high credit score, you won’t qualify for the best mortgage rates available, which could mean you’ll end up paying more money over the term of your mortgage.
Why your credit score matters to lenders
Lenders use your credit score to determine your creditworthiness. Creditworthiness is a lender’s willingness to trust you to pay your debts. A borrower deemed creditworthy is one a lender considers willing, able, and responsible enough to make loan payments as agreed until a loan is repaid. After all, you wouldn’t lend money to someone with a well-known track record of never paying back, will you?
Lenders rely on credit scores as an indication that a borrower will meet obligations. A higher credit score, experts say, reassures lenders that they will be paid back.
How much could a good credit score save you?
According to new data from LendingTree, just a few points difference could save buyers $10,000 or more in interest over the life of their loan. Assuming nothing in a mortgage application changes except the credit score, someone with a score in the 680-699 range would have a mortgage rate approximately 0.399 percentage points higher than a person with a 760-850 score. That’s a difference that may sound minuscule but isn’t.
In 20-years, someone with a 680-699 score will still pay over $20,000 more in interest on a $244,000 mortgage than a person with a high score.
So, what score do you need to consider before applying for a mortgage?
What factors go into a credit score?
To understand how your credit score could save you, first, you must understand what makes up your credit score. While the exact criteria used by each scoring model varies, here are the most common factors that affect credit scores.
- Payment history. Payment history is the most important ingredient in credit scoring, and even one missed payment can have a negative impact on your score. Lenders want to be sure that you will pay back your debt, and on time, when they are considering you for new credit. Payment history accounts for 35% of your score.
- Amounts owed. Your credit usage, particularly as represented by your credit utilization ratio, is the next most important factor in your credit scores. Your credit utilization ratio is calculated by dividing the total revolving credit you are currently using by the total of all your revolving credit limits. This ratio looks at how much of your available credit you’re utilizing and can give a snapshot of how reliant you are on non-cash funds. Amounts owed account for 30% of your score.
- Credit history length. How long you’ve held credit accounts makes up 15% of your score. This includes the age of your oldest credit account, the age of your newest credit account, and the average age of all your accounts. Generally, the longer your credit history, the higher your credit scores.
- Credit mix. People with top credit scores often carry a diverse portfolio of credit accounts, which might include a car loan, credit card, student loan, mortgage, or other credit products. Credit scoring models consider the types of accounts and how many of each you have as an indication of how well you manage a wide range of credit products. Credit mix accounts for 10% of your score.
- New credit. The number of credit accounts you’ve recently opened, as well as the number of hard inquiries lenders, make when you apply for credit, accounts for 10% of your score. Too many accounts or inquiries can indicate increased risk, and as such can hurt your credit score.
Your bank account balance doesn’t appear on your credit report. Neither does your income or your net worth. None of these factors play a role when a scoring model calculates your credit score.
Can I get a mortgage with a low credit score?
It’s possible to qualify for a mortgage even if your credit score is low, but it could be more difficult. A low credit score shows lenders that you may have a history of running up debt or missing your monthly payments. This makes you a riskier borrower.
To help offset this risk, lenders will typically charge borrowers with low credit a higher interest rate. They might also require a larger down payment. Be prepared for these financial hits if your credit is low.